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Arbitrage Trading Based on Cointegration

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Author Info

  • Daisuke Motori

    (Ibbotson Associates Japan)

  • Yukitami Tsuji

    (Keio University, Faculty of Business and Commerce)

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    Abstract

    Does arbitrage trading based on a cointegrating relation work? The efficient market hypothesis insists that there exists no successful trading. In order to avoid problems with data snooping, we choose 5 industrial average indices and a market index to make a cointegration analysis between 6 variables. Many cointegrating relations are found in 3 countries; Japan, the UK, and the USA. Using the facts, we simulate arbitrage trading between a market index and an industrial averages portfolio for each country. The calculation of this simulation shows that the arbitrage is successful. The average returns on the trading are monthly 0.3% to 0.5%.

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    File URL: http://ies.keio.ac.jp/old_project/old/gcoe-econbus/pdf/dp/DP2012-019.pdf
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    Bibliographic Info

    Paper provided by Keio/Kyoto Joint Global COE Program in its series Keio/Kyoto Joint Global COE Discussion Paper Series with number 2012-019.

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    Length: 14 pages
    Date of creation: Nov 2012
    Date of revision:
    Handle: RePEc:kei:dpaper:2012-019

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    Web page: http://ies.keio.ac.jp/old_project/old/gcoe-econbus/
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    1. William Goetzmann & Evan g. Gatev & K. Geert Rouwenhorst, 1998. "Pairs Trading: Performance of a Relative Value Arbitrage Rule," Yale School of Management Working Papers ysm3, Yale School of Management.
    2. Tobias J. Moskowitz & Mark Grinblatt, . "Do Industries Explain Momentum?," CRSP working papers 352, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    3. Joseph Chen & Harrison Hong, 2002. "Discussion of "Momentum and Autocorrelation in Stock Returns"," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 565-574, March.
    4. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    5. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    6. Jonathan Lewellen, 2002. "Momentum and Autocorrelation in Stock Returns," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 533-564, March.
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